How to Make Your Mega Millions Last

Thanks to the millions of starry-eyed dreamers, the Mega Millions Lottery was finally worth $656 million before the winning tickets were sold.

As I discussed yesterday, that's a fair chunk of money-- far too much to spend at once.

But it is fun to think about.

It also makes for a great discussion about how you would begin to invest such an enormous sum.

But here's the thing. Whether you have $656,000 or the entire $656,000,000 jackpot, your thinking is basically the same.

In this case, it is just a matter of scale. It may sound odd but it's true. Let me explain.

If you were lucky enough to hit the big one, here's how you might want to handle the winning ticket.

Mega Millions Decision Number One

Before you did anything, your first decision is whether to take the jackpot in a lump-sum or in annual payments.

Admittedly, after tax and discounting, Saturday's jackpot comes to only $355 million as a lump-sum, or 26 annual payments of $19 million.

The discount rate between the two is only about 2.6%, so if you think you can make more than that on your money, you should probably take it as a lump sum.

Maybe if you wanted to be very conservative on your investments, or thought the stock market was hopelessly overvalued, an annuity would be preferable.

For example, if you had won that amount in early 2000 you might have invested some of the lump sum in the dotcoms before the crash. In that case, you'd have been better off with the annuity!

But market crashes aside, generally, the lump sum looks a better deal.

Then there's the amount you are going to need for your spending spree. I discussed this yesterday suggesting that a spending spree of more than $30-40 million, spread over a year or so, would probably not make you happy and might incur costs for the future.

In particular, you need to be careful not to buy large items that incur running costs.

By all means buy a really nice sailboat, but a $100 million yacht or a house that requires a full staff of servants are likely to drain your resources in years to come, and could lead you eventually to ruin.

To avoid that it probably makes sense to devise a budget for how much you can spend.

If you're fairly young, ideally you would want the money after your spending spree - about $300 million-- to last you the rest of your life.

With interest rates so low and inflation a risk, that means you shouldn't plan on spending more than about $10 million a year in today's money, with spending perhaps increasing along with inflation.

That should be ample for all the toys and lifestyle you want, again provided you haven't bought Downton Abbey or equivalent in a yacht.

How to Invest Your Mega Millions Jackpot

The next thing to be clear about is that you shouldn't invest all the money in the stock market at once.

Here's why.

You don't know whether the stock market is close to a high, in which case your precious winnings will be sadly diminished by a downturn.

Instead, you should invest only 20% of the money in the stock market, split between U.S. stocks and international stocks. An additional 5% should be invested in gold or an equivalent.

And beware of the people that suddenly show up in your life.

As a lottery winner, you will besieged by offers from hedge funds, private equity funds and other mysterious investments, suggesting that you can increase your returns by investing in their funds.

Don't be tempted. At the best, you will only get returns similar to the stock market, but will pay much higher fees to get them, giving away 20% of the profits to get them.

At the worst, you will be investing in the next Bernard Madoff or Allen Stanford. As a lottery winner who is not used to being rich, you are the absolute favorite target for such people.

If you are confident, select the stocks yourself, for at least part of the money.

If not, invest in mutual funds offered by major mutual fund management companies with low fees attached. There are several of these, but as a first pick you can't go far wrong with Vanguard funds.

Diversify between funds and investment types though - you've got the money to do so.

In any case, at least a substantial part of the stocks or funds you buy should pay substantial dividends.

The remaining 75% of your money should be invested in short-term bonds, ideally in a spread of currencies including Canadian dollars, Australian dollars, yen and euros.

Of course, in euros you should only buy the bonds of prime credits, which today means Germany, the Netherlands and Sweden.

Then each year you should invest a further 25% of your portfolio in stocks and gold, in the same way as you did initially, selling bonds to do so.

By doing this, you will have invested your money over a period of three years, which should lessen the risk of having all your money invested at the top of the market.

Three years later, you will end up with a portfolio of 40% domestic stocks, 40% international stocks and 20% gold, with your stocks overall paying dividends of at least 2-3% of their value.
(At present, dividends pay only 15% tax, so are more attractive than bond interest.)

In the long term, you may want to own some bonds, and to sell some of the gold. But you should only do so when top quality bonds yield substantially more than the inflation rate.

At present, even long-term Treasury bonds yield less than inflation, while short-term bonds yield less still.

So the bond markets should be avoided except as a place to park your money for the short-term.

But with the strategy outlined above, you'll minimize the risk of buying at the top of the market - and avoid crooks and high fees - the two biggest risks for the newly rich.

The same thing is true if you have $656,000 to invest. The only difficult factor is that you get the money all at once when you hit the jackpot.

Of course, there are a lot worse problems to have.

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